Daily Archives: June 4, 2012

The number of publicly traded companies in the U. S. continues to fall with a 42% decline from 1997. U.S. publicly traded listings have decreased every single year since 1997 with no rebound at all. ~Edward Kim,

The publicly held corporation– the main engine of economic progress in the U. S. for a century– has outlived its usefulness in many sectors of the economy and is being eclipsed by other more relevant corporate structures.According to Michael C. Jensen; new organizations are emerging, organizations that are corporate in form, but have no public shareholders and not listed or traded on organized stock exchanges.

These organizations use public and private debt, rather than public equity, as their major source of capital. Their primary owners are not households but large institutions and entrepreneurs that designate agents to manage and monitor on their behalf and bind those agents with large equity interests and contracts governing the distribution of cash. Takeovers, corporate breakups, division spin-offs, leveraged buyouts, and going-private are the most visible manifestations of the organizational changes in the economy.

The private organizations are making remarkable gains in operating efficiency, employee productivity, and shareholder value. Whereas, publicly traded companies are in danger of becoming less important as an organizational structure. The rise of the private-equity industry and proliferation of private markets gives more power to a smaller circle of company founders and experienced investors.Public companies have shown an extraordinary resilience through the century, but there are alternative organizational structures that might be better suited for the new economy…

In the article “Eclipse of the Public Corporation” by Michael C. Jensen writes: The forces behind the decline of the publicly traded corporation differ from industry-to-industry. The decline is real, enduring, and highly productive, however, the current trend does not imply that the publicly traded corporation has no future.

The conventional 20th-century model of corporate governance, consisting of; dispersed public ownership, professional managers without substantial equity holdings; board of directors dominated by management appointed outsiders– remains a viable option in some areas of the economy. Particularly for growth companies whose profitable investment opportunities exceed the cash that they generate internally.

These companies can be found in industries, such as; computers and electronics, biotechnology, pharmaceuticals, and financial services. However, the public corporation is not suitable in industries where long-term growth is slow, or where internal generated funds outstrip the opportunities to invest them profitably, or where downsizing is the most productive long-term strategy.

The publicly traded corporation is a social invention of vast historical importance. Its genius is rooted in its capacity to spread financial risk over the diversified portfolios of millions of individuals and institutions and to allow investors to customize risk to their unique circumstances and predilections. By diversifying risks that would otherwise be borne by owner-entrepreneurs, and by facilitating the creation of a liquid-capital market for exchanging risk, the publicly traded corporation lowered the cost of capital.

However, the widespread waste and inefficiency of the public corporation and its inability to adapt to changing economic circumstances have generated a wave of other organizational innovation over the last 20 years; innovation driven by rebirth of active investors. Active investors are investors who hold large equity or debt positions, sit on boards of directors, monitor and sometimes dismiss management, are involved with the long-term strategic direction of the companies they invest in, and sometimes manage the companies themselves. Active investors are creating a new model of general management.

The model is built around highly leveraged financial structures, pay-for-performance compensation systems, substantial equity ownership by managers and directors, and contracts with owners and creditors that limit both cross-subsidization among business units and the waste of free cash flow. Consistent with modern finance theory, these organizations are not managed to maximize profit but to maximize value, with a strong emphasis on cash flow.

More than any other factor, these organizations are motivating the same people, managing the same resources, to perform more effectively under private ownership than in the publicly traded corporate form.

In the article “The Staying Power of Public Corporation” writes: Has the publicly traded corporation out-lived its usefulness? Michael C. Jensen says; Yes. The institutional shortcomings of the public corporation are so grave, he argued, that it must be considered fatally flawed. There are new better forms for an enterprise, which releases much of the untapped value, as well as, corrects many of the inefficiencies of large public companies.

Alfred Rappaport, a professor and consultant, joins the debate with a rebuttal to Jensen. Rappaport shares many of Jensen’s criticisms of current strategic and financial practices among publicly traded companies, but he does not believe leveraged buyouts and other going-private transactions can replace the public corporation.Rappaport argues that the publicly traded corporation is worth saving: It’s inherently flexible and its self-renewing-properties are fundamental to stability and progress in market-driven economy. These characteristics cannot be duplicated in a transitory organizational structure, such as; a private-equity company…

In the article “The Endangered Public Company” by The Economist writes: The number of public companies has fallen dramatically over the past decade– by 38% in the U.S. since 1997 and 48% in Britain. The number of initial public offerings (IPOs) in the U.S. has declined from an average of 311 per year in 1980-2000 to 99 per year in 2001-11. Especially, small companies, those with annual sales of less than $50 million before their IPOs– have been hardest hit. In 1980-2000 an average of 165 small companies undertook IPOs in the U.S. each year. In 2001-09 that number fell to 30.

The burden of regulation has grown heavier for publicly traded companies since the collapse of Enron in 2001. Corporate chiefs complain that the combination of fussy regulators and demanding money managers makes it impossible to focus on long-term growth. Shareholders are also angry.Their interests seldom seem to be properly aligned at publicly traded companies with those of the managers, who often waste millions on empire-building and sumptuous perks.

At the same time, alternative corporate forms are flourishing. Once, ‘going public’ was every CEO’s dream; now it is perfectly respectable to ‘go private’. The increase in the number of corporate forms is a good thing: a varied ecosystem is more robust. But there are reasons to worry about the decline of an organizational structure that has spread prosperity for 150 years…

Fewer IPOs mean fewer chances for ordinary people to put their money in growth companies. The rise of private-equity and spread of private markets are returning power to a club of privileged investors. All this argues for a change in thinking– especially among politicians who heap regulations onto publicly traded corporations, blithely assuming that business have no choice but to go public in the long run.

Many firms now go (or stay) private to avoid red tape. The result is that ever more business is conducted in the dark, with rich insiders playing a more powerful role. The publicly traded company has long been the locomotive of capitalism. Governments should not derail it…

In the article “Why is the Public Corporation in Eclipse” by Larry Ribstein writes: The publicly traded corporation has stayed dominant through modern business history in part because it has political support. In other words, perhaps we should be asking not why the public corporation is threatened, but why, despite everything, it continues to survive. The answer, I think, is the pseudo-democracy of the publicly traded corporation form. Indeed, this explains at least some of the political hostility to private-equity and hedge funds.

These organizations, which truly serve the residual claimants, are a bit too much ‘shareholder activism’ for the so-called ‘shareholder activists.’ The question is how much longer can the rise of the new corporate forms that are threatening to eclipse the publicly traded corporation be delayed.

Everyone, it seems, wants to be private and, particularly, public corporate CEOs, who are concerned about such things as; compliance overkill, preoccupation with risk aversion, lost opportunity cost, inability to pay-for-performance without outcry from public shareholders, and how publicly traded company directors can’t attend board meetings without bringing their lawyers.

The public corporation retains its dominance at least in part because of the strong political support for preserving corporate managers as quasi-bureaucrats who are susceptible to demands of activists, e.g., unions, legislators… I think that the publicly traded corporation may have seen its day, which may seem hard to believe today, when these firms are still so dominant. But mastodons may have felt pretty invulnerable, too, at one point.

During the five decades after Adolf Berle and Gardiner Means published ‘The Modern Corporation and Private Property’ in 1932, their analysis became the dominant doctrine of the U.S. public corporation. Berle and Means did not anticipate an economy dominated by a handful of ever-larger corporations run by an unaccountable managerial class, and inspired scholarship from sociologists (who were convinced they were right) to financial economists (who wanted to prove them wrong) to lawyers (who contemplated the rights and obligations implied by this system).

However, a decade into the twenty-first century the public-traded corporation may have reached its twilight. According to Jerry Davis; it’s notable that the number of public-traded corporations in the U.S. has been in continuous decline since 1997, and the number of IPOs have not kept pace with number of mergers, bankruptcies, and de-listings. It is also notable that even the most successful public-traded companies no longer create many jobs, within their own boundaries, even though they are creating shareholder value.

So, how did this happen? Where did the publicly traded corporations go? One hypothesis is– meddling politicians and regulators required publicly traded corporations to audit themselves more carefully, disclose more information, vouch for it more rigorously, and staff their boards more thoughtfully, e.g., Sarbanes-Oxley… For many companies, the cost of complying with these regulatory demands makes it too costly to ‘go public’ in the U.S.– so instead, they either; stay private, or go to a foreign exchange to list shares where regulations are less stringent…

Another hypothesis is– the public corporation is best suited for the organization in the traditional economy, whereas, the new economy has different organizational characteristics.Outside of retail, energy, and a few other industries; today, many new enterprises have relatively few assets and lower employment: However, they do generate huge profitable revenues… So, why go public? Clearly, many entrepreneurs, VC, and other investors are deciding to skip IPO and stay or go private …

When company ownership is separated from management, the latter will inevitably begin to neglect the interests of the former, creating dysfunction within the company. Some maintain that recent events in corporate U.S. may serve to reinforce Smith’s warnings. ~Adam Smith

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